Speculation and the New Commodity Price Crisis: Separating the Wheat From the Chaff

Wheat prices had been climbing prior to the August 5 announcement of a Russian wheat export ban. Kansas Board of Trade wheat futures contracts had gone from $4.92 a bushel on June 10 to spike at $7.95 a bushel on August 5, prompting a reporter to ask, “How could a Russian drought in the age of instant information escape the world’s notice until the country’s wheat crop was devastated?” This excellent question does not yet have a clear answer.

The wheat price crisis has led the press and even policymakers to focus almost exclusively on the traditional supply-demand fundamentals that ostensibly set prices. It’s as if the press were relieved to point to that old standby, weather, as the culprit for a 50 percent increase in wheat futures prices in a few weeks. For a change from the last three years, excessive speculation in commodities by financial institutions would not be accused of driving price volatility. Furthermore, according to the U.S. Department of Agriculture, unlike 2007-2008, global grain stocks were high enough to supply countries that could afford them. Maybe the specter of speculators increasing hunger might be eluded.

But maybe not. The Financial Times reported on August 4 that Glencore, the largest global commodities trader, had requested the Russian export ban, which was granted the following day. The ban enabled Glencore and other traders to break and “re-price” their relatively lower-price forward and futures contracts. Glencore and other major traders stand to make a killing in the new wheat price environment. So market power, usually a subject for political economy rather than orthodox economics, had a role in moving the fundamentals of price discovery and price transmission.

Glencore and other traders operate under the protection of Swiss banking secrecy laws, safe from the European Commission’s proposed revision of its Market Abuse Directive, about which we have commented. Meanwhile the U.S. Commodity Futures Trading Commission (CFTC) is deliberating how to regulate wheat and other commodity contracts. On August 5, the CFTC’s Agricultural Markets Advisory Committee (AMAC) met to discuss the now three-year old market failure when futures and cash prices for wheat failed to converge as futures contracts (generally 90 days for agricultural commodities) expired. Price convergence is what allows futures prices to be interpreted as reliable price benchmarks for forward contracting of commodities, both by commodity sellers and buyers. The pressure on the Chicago Mercantile Exchange (CME) and other U.S. wheat trading exchanges to solve the price convergence problem was made more acute with the release in June 2009 of a U.S. Senate investigation into wheat prices. The investigation concluded that commodity index fund investors had driven prices by exceeding contract position limits unenforced by the Bush administration CFTC.

CME and other exchange officials had told the CFTC at an AMAC meeting in October 2009 they would redesign the wheat contract to eliminate the price convergence problem, which they attributed to changes in transportation and storage costs and in delivery points (e.g. from Chicago to Toledo, Ohio), rather than to excessive financial speculation in commodities. At the August 5 AMAC meeting, the clearly impatient CFTC Chairman Gary Gensler pressed CME as to when the redesigned contract would finally be ready for review. Six-to-eight weeks was the answer.

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The CFTC has a lot on its regulatory plate. Just to implement the Over the Counter (off-exchange, unregulated transactions) trade provision of the Dodd-Frank Wall Street Reform and Consumer Protection Act, on July 21 the CFTC announced a schedule for 30 new rules. Among the rules will be one on agricultural “swaps” (OTC contracts) that directly affects wheat futures trading.

Because OTC trades are not reported to the CFTC, e.g. by such firms as Goldman Sachs and Morgan Stanley, until well after their market influence has waned, OTC traders do not contribute price information to fulfill the Commodity Exchange Act requirement of price discovery. Regulated exchanges must report their trade data daily to the CFTC for its weekly Commitment of Traders report, a fundamental regulatory tool for estimating trade trends, including market manipulation. Nevertheless, OTC traders take advantage of exchange-traded price information. For this reason and others, former CFTC commissioner Michael Greenberger testified to the CFTC in 2009 that agricultural swaps are per se violations even of the deregulatory Commodity Futures Modernization Act. If OTC wheat trading collapses as the result of a new rule on agricultural swaps, wheat and other agricultural commodity price volatility caused by so-called dark markets will greatly diminish.

But the CFTC faces a tough fight to implement the Dodd Frank legislation, not only because of the massive Wall Street lobby against enforced regulation, but because of continued efforts to deny that financial speculation played a role in price volatility and to argue therefore that Bush administration rules suffice. The latest denialist gambit, by the Organization for Economic Cooperation and Development, to dismiss excessive financial speculation as a major commodity price driver in 2007-2008 has recently been demolished by a Better Markets Inc. study.

However, no amount of prudential regulation, however well-drafted, closely monitored and stringently enforced, will manage the longer term prospect of climate change induced agricultural supply volatility. True, relatively small infrastructure investments could protect the hundreds of thousands of tonnes of wheat that are rotting outside Indian warehouses or the 40 percent of African agricultural production that rots in the fields for want of basic post-harvest storage facilities and roads for domestic markets. But the biggest Greenhouse Gas emitting countries, financial institutions and even some NGOs are counting on carbon emissions markets to induce investments in low carbon technology. The International Emissions Trading Organization opposes limits on OTC trading, ostensibly to make the market “efficient” by increasing its liquidity. Of course, IETA members (many of the same firms that have speculated on agricultural commodities) want their chance to make a carbon killing too.

Steve Suppan has been a policy analyst at the Institute for Agriculture and Trade Policy, a Minneapolis, MN-headquartered non-governmental organization, since 1994.